Avarga – Beneficiary of the Lumber Boom

Lumber prices have been on an incredible bull run, reaching USD 1,326.70 yesterday. Prices have nearly quadrupled from covid lows and are continuing to climb by the day. One big beneficiary of this run up in lumber prices is Avarga. Avarga owns 71.59% of Taiga Building Products, a Canadian listed lumber and building products supplier.

Source: https://tradingeconomics.com/commodity/lumber

What does this mean for Taiga?

1. Further gains in value of inventory: The upward trend in lumber prices has resulted in big gains in value of Taiga’s inventory, leading to record high profits in 2020. The inventory were purchased in the past when prices were lower. So when they sell off the inventory at market prices, Taiga makes supernormal profit margins (gross margins for lumber sales were 10.8% in 2020 compared to normal levels of about 5%). Of course, Taiga would then have to replenish their inventory at higher prices, and profit margins will go back to normal levels once prices stabilise. Since prices have not yet stabilised and are still increasing, we can expect higher than normal margins in the next quarter.

2. Higher volume of sales: The high lumber prices are not only due to supply disruptions, but also due to increased demand. Lumber is a big winner in the post-covid new normal. People in North America are moving out of cities to the towns and suburbs. They are buying single family homes (landed homes rather than apartments). They are also doing more renovations now to make working from home more conducive. They are building fences and patios. Restaurants are building outdoor decks for al fresco dining. Even ignoring the increases in price, sales volume is going up because a lot more lumber is needed for lifestyles of this new normal. In addition to lumber, Taiga also distributes other building materials such as insulation and floor laminate, and we can expect to see an all round increase in demand for their products.

3. Higher recurring gross profits: While lumber prices are not expected to continue rising dramatically, they are not expected to fall much either due to the huge pent up demand. A higher normal price will benefit Taiga because they charge customers a markup based on a fixed percentage.

Illustration of the estimated gross profit per unit of lumber when prices increase from $900 to $1,300

In summary, the current lumber situation bodes very well for Avarga’s main subsidiary, Taiga. I expect that they will continue to do well, and feel that the current prices (PE less than 6) is quite cheap. Some may wonder – if Taiga is so good, then why not invest in Taiga directly? There are pros and cons but the short answer to that is witholding taxes, diversification, and value in the rest of Avarga’s portfolio companies. I currently hold shares in both Avarga and Taiga directly, and will probably write more about it in the next post.

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